I have a US portfolio that is created solely for high beta stocks such as NIO, Tesla, Xpeng and Palantir. These are stocks that you would definitely have heard of if you are vested in the US stock market. At the time of writing, this portfolio sits at negative 20%. If you’re in the same boat as me then this article would most certainly be of interest to you.
If you bought any small-mid cap stock in the past month, there is a high chance that your position is in the red at present. This can be puzzling for some as every other day we see the media reporting that the S&P500 is reaching new highs whereas growth stocks (specifically in the tech sector) are making new lows.
There are reasons why this is happening and at the end of this article, I hope that readers have a better idea of the following investment themes which include,
- Sector Rotation
- Interest Rates
1) Sector Rotation
If you’re wondering why the indexes are moving up but stocks in certain sectors such as EV and tech are going down, one reason can be “Sector Rotation”. This means that investors are still investing in the stock market, but the sectors which they have chosen to put their capital into are no longer the mainstream ones we hear about in the media.
In understanding sector rotations, there are many schools of thought but one which I find easy to understand is the comparison between cyclical ,defensive and disruptive stocks:
The classification of a stock may differ for individual investors, but what is important here is not what we think but what the market thinks as a whole.
For example, a die hard Nike fan who purchases a pair of Nike shoes every week may argue that Nike is a defensive stock because he/she can’t “live” without Nike. However, I can say with confidence that most of the participants in the market do not buy Nike shoes every week and may even stop buying Nike shoes if the economy is not doing too well as there are cheaper alternatives which perform the same function.
If we look at what’s happening now, we have investors pulling away from disruptive stocks as a whole and moving into defensive stocks. This is why the current trajectory of the NASDAQ differs greatly from the Dow Jones Industrial Average or the S&P 500.
As investors, it is always difficult for us to time when such rotations may take place. However what we should always have in mind is that such rotations will happen from time to time.
2) Interest Rates
On the subject of interest rates, this is something that individuals have dedicated their lives to understanding so I’m going to be as concise and accurate as I can in explaining this.
At the most basic level, interest is defined as:
Amount a borrower pays for using someone else’s money.
When we try to understand how interest rates influence the US stock market, there are a few key terms which we need to familiarise ourselves with,:
- Federal Open Market Committee (FOMC) – The monetary policy-making body of the Federal Reserve System, meets eight times a year to set the federal funds rate.
- Federal Funds Rate – Target interest rate set by the Federal Open Market Committee (FOMC) at which commercial banks borrow and lend their excess reserves to each other overnight.
In understanding why the FOMC may initiate a change in federal funds rate, this is something which is influenced by numerous macroeconomic factors. Reference to the events of March 2020 as a case study, the FOMC reduced federal funds rates to almost zero in order to stimulate the economy and encourage borrowing.
Think of it this way, if you want to buy a house and you’re thinking of taking a loan to do so, would you rather buy it when the bank charges you $1 interest for every $1000, or when the bank charges you $0.50 for every $1000?
It’s a no brainer decision, clearly individuals would be more willing to take on loans when the interest rates are low.
The relationship between interest rates and the stock market
Therefore the bottom line here is that, there is an INVERSE relationship between interest rates and the stock market. This is because low interest rates (interest rate cut) encourage consumer and business borrowing, spending and investments. Conversely, when interest rates are high (interest rate hike), consumers and businesses find it more expensive to borrow, spend or invest and will likely cut down on these expenses.
If we look at how this applies to the present, we see a lot of weakness in the NASDAQ. So the question is, are the Federal Funds Rate increasing?
The immediate term answer to this from the FOMC is NO. However the problem here is that the FOMC is expecting Federal Funds Rate to increase in 2022.
The market, being forward looking as always, reacts to this expectation almost instantly, which is why we are having this ‘corrective’ period in the first half of 2021.
The reasons for the FOMC to increase or decrease federal fund rates go beyond merely stimulation of the stock market. Other factors include influencing consumer spending, reducing inflation etc. The reasons are too many to list but if you would like more coverage on this, do drop us a note in the comments section below.
To touch on in greater detail, in my opinion, rising interest rates will always impact companies which are still at a stage of immense growth more than matured companies.
Think of it this way, at present we have companies such as NIO and Xpeng which are aggressively expanding. They are going into new markets like Europe and they are investing in themselves to better their own technology and production capabilities.
If such companies plan to borrow money to finance their growth, they would certainly be more keen to do so in a low interest rate environment as the cost of borrowing would be lower. In a high interest rate environment, companies would certainly think twice about borrowing to finance any expansion and may even decide to cut back on expansion.
In a high interest rate environment, companies would certainly think twice about borrowing to finance any expansion and may even decide to cut back on expansion.
Assuming all else remains the same, any reduction in expansion may result in lower future earnings which will in turn result in the near-term decline of a company’s stock.
When enough companies experience a decline in their stock, this causes the indexes to fall and that may be one of the reasons why the rapid growth of the tech sector has now come to a standstill.
Technical Analysis – Dynamic & Structural Support Levels
When we analyze support levels on a chart, we look at the various points of entry when prices fall to a certain range.
For this analysis, I will be looking at the dynamic support levels of the NASDAQ (Moving Average 120 & 200) as well as its structural support levels (Straight lines).
Disclaimer:
My analysis of the this chart is based on the my study and research and are merely my written opinions and ideas. Therefore the information presented is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice.
Dynamic Support (Moving Average)
As seen from the various moving averages of 50, 120 and 200 plotted on this chart, we’re getting quite a bit of mixed signals from the market.
We have prices that have been frequently breaking up and down from the 50 day moving average (blue arrows) but at the same time, prices have consistently and generally respected the 120 day moving average (orange arrow) right up till last week.
Moving forward from here, it is likely for us to see some consolidation around the 120 day moving average (orange circle) before we experience another move up or down.
Structural Support (Trendlines)
When we plot structural support/resistance levels, we look at key prices where investors have constantly bought and sold. Support levels can be defined as price points where we see repeated levels of buying from investors. Likewise at price points where we see investors selling or taking profit, such areas can be defined as a resistance zone.
With reference to a near-term support level of the NASDAQ at approx. 13,000 (thick purple line), I consider this an extremely important support level as we see investors buying up from this level approximately 4 times in the past 5 months (purple arrows).
If the market were to rely on this support level as a trampoline to the upside, we could see near term resistance at approx. 13,650 (blue line). This resistance level is crucial in the near-term as we have also seen investors sell down at this point approximately 4 times in the past 5 months (blue arrows).
In my opinion, with price action fluctuation between the purple support line (approx. 13,000) and blue resistance line (approx. 13,650), I conclude that index is ranging at the moment.
This is also reflective of the general mood of the market where company earnings are still good with the US economy starting to open up and Covid-19 situation improving but at the same time with some fear and uncertainly spreading with regard to rising interest rates.
If price actions were to break out above the blue resistance line (approx. 13,650), I would conclude that the forming of an ascending triangle could be in motion. In chart analysis, an ascending triangle is when price moves up higher and higher into a key resistance zone before breaking out from that resistance and continuing higher.
Illustrated in the diagram above, the triangle in green indicates a diagram where the support level is gradually increasing (horizontal green lines) with the a key resistance zone forming at approx. 14,200 (red line). Based on the theory behind the formation of an ascending triangle, it is likely that the bull rally can continue if prices acted based on what history has shown us.
While no one can predict the future, an ascending triangle is commonly known to be a continuation pattern in the market and on the very same chart, we see an ascending triangle (in orange) forming not too long ago back in September.
Concluding thoughts
Technical Analysis is never 100% accurate however it can help us to make decisions based on a substantial level of research.
What I like about technical analysis is that it is something that can be quantified, i.e there are numbers, patterns & formulas which guide decision making. However, something I’ve learnt about the stock market thus far is that it hardly ever follows any form of mathematical logic, which is why we need to understand the mood of the market through qualitative analysis (interest rates & sector rotations).
Depending on what type of investor which you are, such movements in the market may not be as important if you’re looking at investing on a longer term horizon.
